Obama-Fueled Mortgages Boost Profit at U.S. Home Lenders

A realtor, at right, gives a tour for potential home buyers during an open house in Manhattan Beach, California. Photographer: Patrick T. Fallon/Bloomberg

Oct. 10 (Bloomberg) -- Wells Fargo & Co. and JPMorgan Chase
& Co., the largest U.S. home lenders, will post third-quarter
profit buoyed by government policies intended to help borrowers.

Those firms, along with No. 3 U.S. Bancorp and fourth-ranked Bank of America Corp., may report $6.9 billion of
mortgage-banking revenue in the period, a 37 percent increase
from a year earlier, Christopher Kotowski, an Oppenheimer & Co.
analyst, said in a research note. That will help the companies
generate a combined $10.9 billion in profit, according to the
average estimate of analysts surveyed by Bloomberg.

The figures show the degree to which U.S. lenders have
become dependent on revenue from mortgages to cushion weakness
in other lending and investment-banking businesses. The banks
are benefiting as President Barack Obama’s administration
targets housing in an effort to stimulate the economy. They’re
earning more on each home loan they sell as Federal Reserve
purchases of mortgage debt widen profit margins.

“Government policy is encouraging banks to make mortgages,
and they want to keep it that way,” said Nancy Bush, an analyst
and contributing editor at SNL Financial LC, a bank-research
firm in Charlottesville, Virginia. “For them it’s sort of a
beneficent cycle right now.”

Lenders are generating revenue as middlemen between
government-controlled mortgage firms such as Fannie Mae and
Freddie Mac, which provide about 90 percent of the funds to the
housing market, and borrowers looking to take advantage of
record-low interest rates.

The four banks will post $7.25 billion in mortgage revenue,
according to estimates by KBW Inc.

Refinancing Boom

Obama has pushed for more refinancing for homeowners
underwater on their mortgages, and the administration last year
broadened the Home Affordable Refinance Program, known as HARP,
so that more people qualify. Almost 900,000 homeowners have used
the program to refinance since 2009, according to the Federal
Housing Finance Agency.

In all, consumers refinanced $305 billion of home loans in
the three months ended Sept. 30, according to estimates from the
Washington-based Mortgage Bankers Association. That’s the most
since the fourth quarter of 2010, and a 52 percent increase from
a year earlier, the group estimates. Refinancings accounted for
74 percent of the $412 billion in originations, the MBA said.

Central bank policy also is helping lenders. On Sept. 13,
the Fed said it would buy $40 billion more in mortgage
securities each month to stimulate the economy. The housing
market is “one of the missing pistons in the engine” of the
economic recovery, Chairman Ben S. Bernanke said at a press
conference after the announcement.

‘Useful Outcome’

“Housing is usually a big part of a recovery process,” he
said. “We haven’t had that nearly to the usual extent. And to
the extent that we can support housing, I think that would be a
very useful outcome.”

The announcement, dubbed QE3 after two earlier efforts,
pushed rates that already had reached historic lows to new
depths. That helped increase lenders’ profit margins in the
quarter, a trend that probably will persist, Ed Najarian, an
analyst at International Strategy & Investment Group Inc. in New
York, wrote in a Sept. 30 note.

The biggest banks benefit the most from the Fed’s actions
because they have the largest pools of clients to approach for
refinancing and already have customer information needed to
underwrite loans, said Thomas Lawler, a former Fannie Mae
economist who’s now a housing consultant in Leesburg, Virginia.

Pricing Power

“They have more pricing power, and it comes down to what
the market will support,” said Jennifer Thompson, a bank
analyst at Portales Partners LLC in New York. “Banks are in the
business of making money.”

Between the Fed’s announcement and Sept. 28, the last
business day of the quarter, the rates offered for new 30-year
mortgages fell by 0.10 percentage point, compared with a drop of
about 0.28 percentage point for yields on the bonds into which
the loans get packaged, according to data compiled by Bloomberg
and Bankrate.com. The gap between the two, which typically
signals increasing lender revenue when it widens, reached a
record of more than 1.7 percentage points on Sept. 25.

“This is another form of a bailout,” said William Black,
an associate professor of economics and law at the University of
Missouri-Kansas City and a former U.S. bank regulator. “It
transfers a whole lot more money to the banks than to people. It
also gives homeowners more disposable income and potentially
creates a wealth effect. The lower the interest rate, the higher
home values should be. But in that transmission process, the
banks will end up wealthier.”

Mortgage Settlement

Those same banks helped fuel the housing boom and
subsequent financial crisis by easing underwriting standards and
packaging defective loans into securities for sale to investors.

In February, the five biggest mortgage servicers agreed to
a $25 billion settlement of state and federal probes into shoddy
foreclosure practices. New York Attorney General Eric T.
Schneiderman this month accused a unit taken over by JPMorgan of
deceiving investors on the quality of mortgage bonds and said
the industry faces billions of dollars in damages. The U.S.
government yesterday sued Wells Fargo over claims the bank
committed fraud by making reckless mortgage loans.

Shares Rebound

Mortgage-banking may account for 9.3 percent of third-quarter revenue at the four largest home lenders, up from 6.5
percent a year earlier, Oppenheimer’s Kotowski wrote in a Sept.
25 report. He estimated a record $2.95 billion for Wells Fargo,
$1.85 billion for New York-based JPMorgan, $1.6 billion for Bank
of America and $450 million for U.S. Bancorp.

Ancel Martinez, a Wells Fargo spokesman, declined to
comment, as did Dan Frahm of Charlotte, North Carolina-based
Bank of America, JPMorgan’s Amy Bonitatibus and Tom Joyce at
U.S. Bancorp.

Wells Fargo originated 33.1 percent of all U.S. mortgages
in the first six months of the year, according to Inside
Mortgage Finance, an industry publication. JPMorgan originated
11.1 percent; U.S. Bancorp, 5.4 percent; and Bank of America,
4.4 percent, according to IMF.

Lenders’ shares have rebounded in 2012 after last year’s
declines amid signs that U.S. housing was improving. Bank of
America surged 66 percent, U.S. Bancorp jumped 28 percent, Wells
Fargo rose 28 percent and JPMorgan advanced 26 percent. The 24-company KBW Bank Index, which dropped 25 percent last year, has
gained 29 percent in 2012. Housing prices bottomed earlier this
year and have climbed since March, according to the S&P/Case-Shiller index of 20 U.S. metropolitan areas.

Interest Margins

Some banks have said analysts are overestimating profits.
Wells Fargo Chief Financial Officer Timothy Sloan said July 13
that reports saying margins on HARP loans were larger than other
originations “wasn’t the case” and “isn’t the case now.”

There may be factors that erode or eliminate the impact of
mortgage-banking revenue on profits. Expenses may climb, and
income from mortgage bonds that lenders hold as investments may
be curtailed if yields decline, analysts including Portales’s
Thompson said.

Wells Fargo, which outlined a plan last year to cut $1.5
billion in quarterly costs by the end of the year, has stepped
away from that goal as more revenue becomes available. The San
Francisco-based bank added more than 2,000 workers in the second
quarter, and Chief Executive Officer John Stumpf, 59, said on
May 31 that “revenue still is king or queen” and that he
“won’t be slavish” to the cost-cutting goal.

‘Margin Pressure’

Wells Fargo’s Sloan told analysts last month that third-quarter net interest margin, the difference between what the
bank makes on loans and pays for funds, may narrow by about the
same as last year’s 0.17 percentage point.

“The drop in mortgage and MBS yields will lead to even
more severe net interest margin pressure than previously
anticipated,” Najarian wrote.

Still, mortgage banking is expected to help the largest
lenders. JPMorgan, led by CEO Jamie Dimon, 56, will post a $4.87
billion profit for the quarter, according to estimates of 13
analysts surveyed by Bloomberg, an increase of 14 percent over
the same period last year. Wells Fargo will report net income
rose 19 percent to $4.83 billion, according to estimates of 14
analysts. Both firms report results Oct. 12.

U.S. Bancorp will post $1.43 billion in third-quarter net
income, a 13 percent increase from a year earlier, according to
13 analysts surveyed by Bloomberg. The Minneapolis-based company
will report results Oct. 17.

Moynihan Retreat

At Bank of America, revenue from the business may mitigate
a $1.6 billion litigation expense the firm said it will take in
the quarter after agreeing to pay $2.43 billion to investors who
suffered losses tied to its purchase of Merrill Lynch & Co.

The bank will post a $276.3 million loss when it reports
results Oct. 17, according to the estimates of seven analysts
surveyed by Bloomberg. That compares with a $6.23 billion profit
in last year’s third quarter driven by more than $6 billion in
accounting gains tied to deterioration of its credit spreads.

Bank of America’s 2008 purchase of Countrywide Financial
Corp., which made it the biggest mortgage lender and servicer as
the bottom was falling out of the U.S. housing market, saddled
the firm with more than $40 billion in costs tied to shoddy
loans and foreclosures.

In response, CEO Brian T. Moynihan, 53, pulled back on
originations to move employees into servicing delinquent
borrowers and to reduce assets regulators deemed risky. In
February, some Bank of America customers were asked to wait as
long as 90 days before starting to refinance mortgages.

Moynihan, whose bank missed out on the surge in mortgage
business this year, has said the firm’s market share will rise
as it increases sales of home loans to existing customers.

“The banks have to generate profits” from somewhere, SNL
Financial’s Bush said. “The housing market is one of the few
bright spots.”